Chesapeake Energy Is Reducing Leverage at the Wrong Time

Chesapeake Energy (NYSE: CHK) is a prime example of a company that overspent in the past and is now forced to cut back spending during the market rebound. The worst part of it all is that the energy company is forced to unload assets that apparently aren't wanted by the market at favorable valuations.

In not much of a big surprise, Chesapeake Energy finished spinning off the oilfield services division to existing investors due to a lack of market appetite for the service firm faced with the reduced drilling spending of the parent. In addition, the company announced several other transactions to reduce leverage.

The company pales in comparison to EOG Resources (NYSE: EOG) , which continues to find new oil, and Apache Corp (NYSE: APA) , which continues expand oil production. Both stocks trade at premium enterprise values to Chesapeake Energy despite the latter actually having higher production levels and revenue.

The dealsIn total, Chesapeake Energy expects to reduce leverage by $3 billion via several transactions that will mostly remove debt from the balance sheet -- a clear sign that the market doesn't value the assets the company is attempting to unload. The deals include the following:

Transfer Chesapeake Cleveland Tonkawa, L.L.C shares to the preferred members to eliminate $1 billion in equity attributable to third parties and $160 million of balance sheet liabilities.

Sell noncore-producing assets in Oklahoma and Texas for approximately $310 million in cash.

Sell noncore acreage with minimum production in Southwest Pa. and the Powder River Basin in Wy. for combined proceeds of $290 million.

The asset sales reduce net production by only 2% while removing a substantial amount of liabilities from the balance sheet. It does reduce operating cash flow by $250 million though it does eliminate roughly $200 million in capital expenditures for the year.

Still not spending in 2015The excesses of the past have Chesapeake unwilling to spend now that the natural gas market is improving. The company claims to be the second largest producer of the energy source in the U.S., yet it continues to constrain capital spending despite low inventories and improving prices. After a brutal winter season and now over a month of inventory builds, natural gas inventories still sit 31% below the 5-year average.

For 2015, Chesapeake Energy is targeting production growth of 7–10% compared to 2014 production adjusted for the impact of asset diversification. In total, the company expects to spend $5.5 to $6.0 billion on capital expenditures. This spending level compares to production capital expenses of $5.0 to $5.4 billion this year and significantly higher amounts in previous years.

While Chesapeake Energy continues to constrain capital spending in order to reduce debt and leverage, both Apache and EOG Resources are aggressively growing oil production. Naturally it helps that both have higher levels of oil production. In the case of EOG, the company has an enterprise value of over $60 billion, yet production sits at only 563,500 boe/d. With roughly 45% oil and growing at around 29% for the year, it's not hard to see why investors favor the stock.

Apache doesn't have the same high valuation, yet due to liquids production at 58% of total production the stock is valued favorably. The company is also very aggressive with 38 rigs operating in the Permian Basin helping increase average daily production in the region to 150,000 boe/d. In total, Apache produced 640,000 boe/d for the first quarter. The company spent over $2.4 billion for the quarter, exceeding the prior year by over $200 million and far exceeding the amount spent by Chesapeake.

Bottom lineUnfortunately, Chesapeake Energy needs to continue reducing leverage at the moment it should spend more on attractive projects. In addition, the company appears to be unloading assets including the oilfield services division for nearly nothing at a time that the market is improving. This scenario further highlights the need for firms to remain prudent in spending in order to not get too far out on their skis. Once liquidity is lost, the lack of financial flexibility is a killer to corporate plans.

Do you know this energy tax "loophole"?You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

"This scenario further highlights the need for firms to remain prudent in spending in order to not get too far out on their skis." Hmm, not one mention of Aubrey McClendon and how his "wild cat" mentality placed the company in the exact state it is now de-levering from. The adults have control of the company now, and its better days lie ahead.